As we sift through the rubble in our growth portfolios, we come up against the two age-old investing questions:
1. What should I sell now that is not coming back?
2. What should I buy now that will provide my portfolio stability and better returns going forward?
Everyone has their process for making such decisions. I use a scoring algorithm.
Why do I score my current growth holdings and stocks of interest?
Because it allows me to sift through dozens of potential candidates to short list the ones that have the best potential to perform well in 2022-2023. It helps me put a numerical score to each of the key metrics that I believe demonstrate the current business health and future business potential for the company. I also use this quantitative method to quickly compare two stocks in the same industry…this year, especially, I want to ensure that my money is in the strongest growth stocks that are performing well amidst all the market volatility.
Sure, I could do all sorts of fancy future-forecasting analysis, extrapolations and discounted cash flow forecasting, but that would end up with guesses upon guesses that might not come to fruition. I prefer to keep it simple and grounded in facts - actual reported business data that is in the earnings reports of these companies.
These scores change from quarter to quarter as companies report their most recent performance. Stock price performance showed that the highest scoring stocks as a cohort are down about 27% since Dec 15th, 2021 when the US Fed announced its hawkish intentions to raise interest rates. The lowest scoring stocks are down about 39% during that same timeframe.
Here is how I tabulate the points in my scoring algorithm:
Revenue growth YOY (most recent quarter) > 50% (1 point: 1 weight).
Revenue growth FWD YOY > 40% (1 point: 2 weights). 1 extra point if > 100%.
Average revenue growth QOQ for last 3 quarters + est. next quarter > 10% (1 point: 1 weight).
Gross margin > 50% (1 point: 2 weights). 1 extra point if > 80%.
EBITDA rising for at least 3 of last 4 quarters (1 point: 1 weight).
Average customer growth QOQ for last 4 quarters > 10% (1 point: 2 weights).
Cash on balance sheet > $500M (1 point: 2 weights).
Cash flow from operations rising for at least 3 of last 4 quarters (1 point: 1 weight).
Free cash flow rising for at least 3 of last 4 quarters (1 point: 1 weight).
Total debt / Total cash on hand < 0.75 (1 point: 1 weight).
Institutional ownership rising for at least 3 of last 4 quarters (1 point: 1 weight).
Average RPO increase for last 4 quarters > 10% (1 point: 1 weight).
Extra credit for having a sector tailwind present (1 point: 1 weight).
Extra credit for having a market dominant position (1 point: 1 weight).
Extra credit for having an active buyback program in progress (1 point: 1 weight).
Extra credit for entering new major markets or release new major products in 2022 (1 point: 1 weight).
Negative point if there are external factors putting pressure on the stock (1 point: 1 weight).
Negative point if the original thesis (product/growth/profitability etc.) has changed (1 point: 1 weight).
Note:
- Price is not used in the scoring. I want to evaluate these companies solely on their past business performance and future business prospects.
- The RPO metric above will give a small advantage to stocks that sell their services on a subscription basis. This is by design because their business model creates a contractual 2-5 year revenue pipeline…thats a good thing.
- I am experimenting with two more criteria and might introduce them later this year if they seem to work - a valuation metric (EV/GP) and fair market value.
No business evaluation method is fool-proof nor is this one. However it works better for me than blindly following someone’s else’s recommendation, a fintwit post or over-sensationalized media headlines. Your criteria might be different from mine…this is what makes a market…differences in opinion and portfolio performances are then predicated on these differences.
I am a numbers guy at heart. These scores, fall as they may each quarter, give me confidence that I am not missing any important criteria. I can then make a clear cut investing decision on each stock.
I am currently plotting an action plan to tweak my portfolio to recover as quickly as possible from the recent carnage. This scoring approach is an integral part of that exercise.
https://beachman.substack.com/p/its-time-to-plot-our-comebac…
Beachman (@Iwannabeontheb2)